August 2005
Greetings to all from inside the Lompoc, California Federal Correctional Complex, Satellite Camp:
On July 1st I reported to this facility and am settling into the routine. More about my daily tasks and challenges in a future newsletter. Suffice it to say that loss of freedom and not being with my beloved wife Mary Ann, are most difficult, as is being “out of the loop” for awhile on tax and estate planning issues and solving client problems (even as a non-lawyer consultant). Fortunately, Ramsbacher Prokey LLP is providing me with articles and bulletins on new developments.
Most persons receiving this initial newsletter (thanks to the assistance of Mary Ann and my webmaster, our son Mark) have tracked my tax case from indictment to sentencing. I have great remorse for my actions that led to this situation and apologize to family, as well as to professional associates, clients and other friends, asking for your forgiveness. Eighteen months of incarceration to me seems like a long time, even though my actual release date is October 22, 2006 and there are other time-shortening possibilities. I am committed to serving my sentence with honor and dignity.
Mary Ann and I have appreciated so much the outpouring of caring support. I hope to be back in the fall of 2006 reestablishing a productive consulting practice. As indicated by comments later in this newsletter, estate planning, entity structures (including FLPs), valuation issues all remain very important – no matter what the future of the federal estate tax. Family dynamics and interpersonal relationships are reflected in property and wealth transmission issues and planning no matter what the current tax situation is at any given point in time. In truth, wealth preservation has as much to do with designation of the manager or management, and successor managers, as it does with the tax system.
Sometime this year, the bitter debate over the federal estate tax may (but may not) be resolved. Given the nation’s budget deficit and conflicting political positions, full repeal is perhaps unlikely (and, in any event, the states’ transfer taxes and the carryover income tax basis issues show estates would not get a “free ride” even with full repeal of the federal estate tax). Will exemption limits be pegged at $3.5 million per person or even $10 million per person in lieu of complete repeal? And, in any event, how will planners deal with the $1 million limit on gift tax-free transfers? Much uncertainty remains and planning for high wealth clients will continue to be the focus of estate planners, who of course must consider income tax issues as well as those relating to the transfer tax. I suggest for study an excellent, thought-provoking article by Louisiana attorney, L. Paul Hood, Esq., titled “Hermeneutic for Evaluation, Selection and Design of Estate Planning Tools and Techniques”, Tax Management Estates, Gifts and Trusts Journal, May 12, 2005, at pp. 155-175. This article discusses a tool of analysis and interpretation (“hermeneutic”) for evaluating and designing estate planning techniques. More on the human and “fitting the plan to the family” issues in a future newsletter.
The New and Expanded Circular 230
Tax practitioners and valuation appraisers have been properly concerned about the newly revised and expanded Circular 230, the Treasury’s rules for practice before the IRS, effective June 21, 2005, relating to any federal tax. Must reading are the following two Tax Notes articles:
- Blattmachr, Gans and Bentley, “The Application of Circular 230 in Estate Planing”, April 4, 2005;
- Blattmachr, Gans, Zeydel and Bentley, “Circular 230 Redux: Questions of Validity and Compliance Strategies”, June 20, 2005.
Clearly, any professional providing advice to clients on tax matters, especially written advice, must study and understand the revised Circular 230. Of course, this requires client education and understanding as well. There is an addition, as part of May, 2005 changes to Circular 230, of a “safe harbor” for a transaction having as its purpose the “claiming of tax benefits in a manner consistent with the statute and Congressional purpose.” The meaning and impact of this “safe harbor” itself is open to interpretation. One wonders about the additional cost of planning by reason of the revised Circular 230 as well as how IRS field personnel will use it.
Schutt and The “Bona Fide Sale” Exception to IRC Secs. 2036 and 2038
The use of family limited partnerships (“FLPs”) and limited liability companies to preserve and manage family wealth has been popular for decades. However, taxpayer and advisor planning and operation errors and excessive claims on valuation discounts have led to nearly 10 years of IRS attack on these entities, with resulting litigation. Several court decisions have shown the way out of problems with IRC Secs. 2036 and 2038, the principal IRS challenges to entity validity. These decisions include Stone Estates v. Commissioner, T.C. Memo. 2003-309, Estate of Kimbell v. U.S., 371 F.3d, 257 (5th Cir., 2004) and most recently, Estate of Schutt v. Commissioner, T.C. Memo. 2005-126, involving creation of “business trusts.” What is reviewed here is qualifying for the statutory “bona fide sale” exception to Sections 2036 and 2038. In forming and funding the FLP, there must be present both a bona fide sale and full and adequate consideration, as analyzed in detail by the Tax Court in Bongard, 124 T.C. No 8 (2005).
As to the “bona fide sale” requirement, the facts must show there to be a significant non-tax reason for the entity. Four factors then support there being “full and adequate consideration,” namely, (i) proper credits to capital accounts for contributed assets, (ii) entity interests proportionate to asset values contributed, (iii) pro rata distributions charged to capital accounts, and, once again (iv) a legitimate, significant non-tax reason for the entity. See the Leimberg email newsletter and tax attorney Steve Akers’ article therein: LISI Estate Planning Newsletter #837 (6/14/05), at www.leimbergservices.com.
Strangi Decided by 5th Circuit
The long saga of the Strangi case now appears over with the 5th Circuit’s opinion and affirmance of the Tax Court’s application of IRC Sec. 2036(a)(1) to the Strangi FLP. Albert Strangi, et al. v. Commissioner, 5th Cir., filed 7/15/05, No. 03-60992, affirming (on 2036(a)(1) inclusion only) T.C. Memo. 2003-145. As set forth in the Milford B. Hatcher, Jr. analysis in The Leimberg Estate Planning Newsletter #853 (7/21/05), see www.leimbergservices.com, the 5th Circuit using the “clearly erroneous” standard of review of the trial court’s decision, was very fact specific in analyzing the Strangi case and chose to apply only Section 2036(a)(1). Thus, the appellate court found that “ . . . we cannot say that the Tax Court clearly erred in holding that Strangi and his children had some implicit understanding by which Strangi would continue to use assets as needed, and therefore retain ‘possession or enjoyment’ within the meaning of Sec. 2036(a)(1).” Further, the appellate court found that the “bona fide sale” exception to 2036(a) application was not available here since “as an objective matter” the transfer of assets by Mr. Strangi to the FLP did not serve a “substantial business or other non-tax purpose.” Each of the Petitioner’s five (5) alleged non-tax purposes were rejected on the facts as found by the Tax Court.
The 5th Circuit, in applying 2036(a)(1) pointed out (see footnote 4) that the “controlling” question was whether Mr. Strangi “ . . . received a general assurance that his assets [apparently meaning those transferred to the partnership] would be available to meet his personal needs.” Among the key facts leading to 2036(a)(1) application were (1) repeated distributions from FLP to pay debts and expenses of Mr. Strangi or his estate, (2) continued possession of his residence by Mr. Strangi without payment of rent (even though rent was “accrued”), (3) transfer to the FLP of 98% of his assets, leaving Mr. Strangi in an illiquid position.
Also, my view is that the use by Mr. Strangi’s son-in-law of the “Fortress Plan” FLP package and the death of Mr. Strangi two (2) months after FLP formation were negative facts contributing to the Petitioner’s ultimate defeat. Now, it would appear, tax planers and their clients have plenty of guidance as to how properly to design, document, fund and operate an FLP/FLLC program having multiple significant purposes, both tax and non-tax in characterization.
That’s All For Now
I sincerely hope this newsletter was of interest. Your comments and suggestions (including who should receive this and future newsletters) are most welcome.
Sincerely,
Owen Fiore
